Authorities in Burma have signed a ceasefire agreement with ethnic rebels in the east of the secretive country, taking a big step toward ending one of the world's longest-running insurgencies.

The move comes amid tentative progress towards reform in Burma, which has been ruled directly or indirectly by the military since 1962.

A nominally civilian government was appointed last year, pro-democracy campaigner Aung San Suu Kyi freed from house arrest and censorship eased.

In another sign that the government is inching towards reform, state media announced on Thursday that 651 prisoners would be freed.

Recent amnesties have disappointed opposition activists as they included only a few of the southeast Asian state's political detainees.

Along with free elections and the release of political prisoners, peace with the dozens of ethnic groups fighting the authorities is one of the conditions laid out by western governments before sanctions imposed by the EU and the US can be lifted.

William Hague, the foreign secretary, repeatedly raised the issue during a visit to Rangoon and Naypyidaw, the Burmese capital, last week – as did Hillary Clinton, the US secretary of state, during a visit in December.

Aung San Suu Kyi said last week that "unless there is ethnic harmony it will be very difficult … to build up a strong democracy".

A decision on the sanctions will be taken by the EU's foreign affairs council in April.

Agencies in Rangoon reported that the government's peace committee met leaders of the Karen ethnic group in the Karen state capital, Pa-an, on Thursday.

A government official said "a ceasefire agreement has been signed" between the authorities and the Karen national union, a rebel group.

Karen rebels have been fighting for autonomy for 63 years and were the only main ethnic community in Burma not to have concluded any kind of peace agreement with the government.

Violence between the Burmese army and ethnic groups living along the borders has displaced millions of people and caused huge suffering in the decades since Burma gained independence from Britain in 1948.

Military offensives have often been accompanied by systematic rape, torture and the use of forced labour, human rights groups say. Millions have been forced into exile, with many fleeing into neighbouring Thailand.

An agreement with groups representing the Kachin ethnic minority in the northeast broke down last summer.

Military operations – despite an order given by Thein Sein, the president, last month – appear to be continuing.

Aid workers in Burma said on Thursday the situation is deteriorating, with more than 50,000 Kachin people forced from their homes over the past six months.

The Karen for a long time fought successfully against the Burmese authorities from jungle-covered hills near the border with Thailand before a lack of unity weakened the movement.

Karen diaspora groups cautiously welcomed the peace agreement but warned that it remained unsafe for exiles to return to Burma.

Karen Communities Worldwide, a rights group, said: "We have seen how human rights abuses have continued in other areas of Burma where there are ceasefires, and how the dictatorship used the ceasefires to extend its control … A ceasefire alone tackles the symptoms, not the causes. There must also be political dialogue for a permanent political solution."

There have been several rounds of ceasefire discussions between the Karen and central government, most recently in 2005, but none resulted in agreement.

One analyst in Burma described the agreement as groundbreaking but said genuine economic development was now important to make sure any peace was durable.

"The previous ceasefires in the 1990s become an opportunity for [some leaders] to enrich themselves and intensified the extraction of natural resources," he said.

One example was extensive logging by Chinese companies in Kachin areas, he said, and opium poppy cultivation and drug manufacture had also boomed.